PMPK: mixed signals?

PMI global should pay heed – 2018 was a breakthrough year for its Pakistani subsidiary, which recently announced a factory closure. As per a company notice sent to the bourse last week, Philip Morris (Pakistan) Limited (PSX: PMPK) closed the year ended December 31, 2018 with on a high. The double-digit growth in net turnover is the highest this decade; so is the growth in bottom-line. The gross margin (37%), operating margin (4%) and net margin (3%) have all held steady for the year.

PMPK’s strong showing in 2018 follows a similar performance by Pakistan Tobacco Limited (PSX: PAKT), whose net turnover grew by 23 percent year-on-year in CY18. Income statements of both these companies have experienced turnaround since the government’s introduction of a three-tier tobacco FED regime in the middle of 2017.

The tobacco majors defend the multi-tier FED system – which has made cigarettes cheaper, mainly in the value-for-money segment – as critical in helping them take back the market share from duty-non-paid (DNP), locally-manufactured smokes. There is no independent estimate of how much illicit trade actually is, but PAKT, in its recent Directors’ Review, put the market share of illicit cigarettes at 33.2 percent.

If that estimate is true, it’s a very high number that is somewhat irreconcilable with the strong top-line growth shown by the duopoly lately. For its part, PMPK, despite healthy financials, is making arrangements to close down its cigarette-manufacturing facility in Kotri (Sindh), which was a cost center for the firm, as per a source. Publicly, PMPK has attributed this retrenchment to “wide presence of illicit cigarettes in the country”.

The factory closure would likely make the government receptive to tobacco industry’s request ahead of the next budget due in June 2019. Sources suggest that the government will likely keep the three-tier FED structure in place and only allow an inflation-adjusted increase in FED per slab. The tobaccos will cast that as a relief, but health advocates will not like it.

In the wake of systemic failure of law enforcement and tax authorities to crack down on DNP brands, the multi-tier FED regime was the government’s compromise – or middle ground – to restore its tax billions and keep the formal sector competitive. Let’s see if the new government has the appetite to take on the DNP tobacco economy. In the long run, government’s objectives of fiscal health and public health can best be met through a rigorous and consistent enforcement drive targeting illicit trade.